Stocks On A Rampage: Recent Returns Signal A Good 2020
Many predicted there would be a correction in January, but instead we have seen a continuation of this rally for the ages. S&P 500 is already up 1.78% year to date. That’s almost half the gains expected for the entire year. In this article, I will show tons of charts that support the position that a solid correction of about 10% is coming shortly.
Firstly, we have the lone positive table in this article which shows how stocks start the year is a good indicator of how the rest of the year will go. With the S&P 500’s PE ratio already at about 18.7 (depending on which estimates you review) it’s hard to imagine such returns occurring.
As you can see, when stocks are positive in the first 5 days of the year, like they were this year, the average and median gain for the full year is 13.6% with gains occurring 80% of the time. S&P 500 was up 0.69% in the first 5 days which puts it in the category shown in the 4th column of this table.
Returns of 0.65% or higher in the first 5 days bring average yearly returns of 17.2% with gains happening 88.6% of the time. I don’t see such a rally occurring this year.
With the S&P 500’s 0.7% rally on Monday, it hit a new record high. CNN fear and greed index stayed at 91 which is extreme greed. It hasn’t been in extreme greed for this long in at least the past 3 years. VIX fell 0.24 to 12.32. It’s not as low as it was in 2017, but I’d argue stocks are at least as overbought.
As you can see from the chart below, the 50 day rolling total of days where the S&P 500 has been overbought is near 100% and this doesn’t include Monday’s rally. Friday’s decline caused the 14 day RSI to fall to 67.13, but I think it went back above 70 with Monday’s increase.
3 Charts Showing Stocks Are Too High
Put to call ratio is very low. The chart below gives greater detail. As you can see, the 5 day, 10 day, and 25 day moving averages of the put to call ratio are in the 5th percentile which is a sell signal. The top chart of the S&P 500 shows red arrows when these signals have gone off in the past 4 years. They only went off in December 2017 and January 2018.
Based on 3 month forward returns, they were correct 12 out of 12 times because the market fell. On the opposite side, when the indicators were in the 95th percentile, this signal was correct 9 out of 10 times as stocks almost always increased. Furthermore, the 50 day put to call ratio is 0.56 which has only been reached 8 times in the past 20 years.
A chart from Sentiment Trader shows its options speculation index. As you can see, it is the highest since 2000. That was one of the most euphoric markets in history. Last week 21.6 million speculative call options were bought which is the most ever. I’m assuming speculative call options are out of the money call options.
That means the strike price is above the current price. If the current price doesn’t increase, the option will expire worthless. Most do expire worthless. Previous record was 19.7 million on January 26th, 2018. I never though we’d see euphoria metrics in this cycle surpass those in January 2018, but here we are. Total bullish/bearish volume was the highest since March 2000 which was the top of the tech bull market.
Finally, we have consolidated equity positioning in the chart below. As you can see, the chart shows the week to date average of z-scores for positioning and flows. Weights in the average are based on the explanatory power in the regression. Which I’m assuming means which indicator has the highest R-squared.
Equity positioning is in the 96th percentile of its historic range. Since the bull market started, it has only been significantly higher in January 2018. At least this chart shows the market slightly less overbought than then.
Review Of Monday’s Action
Nasdaq was up 1.04% as it continues to be on a rampage this year. It’s already up 3.36% year to date as Apple and Tesla lead it higher. Russell 2000 was up 0.72%. It hasn’t been doing as well in the past few weeks as the smaller the company, the worse it has done. The chart below is from before Monday’s rally.
As you can see, even within the S&P 500, the average year to date change of the largest 10% of companies is the best and the average change of the smallest 10% of companies is the worst.
Only news on Monday was that America removed calling China a currency manipulator. That signals trade talks are going well. There wasn’t any economic data released on Monday. It seems like stocks are on autopilot.
Speaking of autopilot, Tesla stock rallied an enormous 9.77% as it’s now worth more than Ford and GM combined. It’s only behind VW and Toyota in terms of market cap. Its stock is up 25.47% year to date. It was wrong to say to take profits.
Many have said to short Apple which hasn’t worked so far this year. Its stock was up 2.14% on Monday and is up 7.94% year to date. Both stocks will likely lead the market lower in a correction. Charts below show Apple’s valuation. Apple’s free cash flow yield has fallen and it has fallen in relation to the S&P 500’s free cash flow yield.
It’s no surprise tech was the 2nd best performer on Monday as it increased 1.34%. The sector is up 4.21% year to date. Best performer was materials which increased 1.36%. The only down sector was healthcare which fell 0.35%. Bernie Sanders’ odds of being the Dem nominee have increased to 34% which is just 5% below Biden.
On Saturday, a poll showed Sanders was winning Iowa by 3 points. However, later on Monday, polls came out showing Biden winning Iowa by 6 points and New Hampshire by 4 points. Let’s see how Tuesday’s debate impacts the race.
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